Title: Taxes and Development: India vs. China
1Taxes and DevelopmentIndia vs. China
2Taxes and Economic Growth India vs. China
- What is the role of tax structure in economic
growth in India? - Evolution of tax structures remarkably similar to
that in China - Surprising given very different political systems
- Objective of presentation
- Lay out similar development of tax structures
during the reforms in the two countries - Suggest a story to explain the observed interplay
between taxes and economic reforms
3 Pre-reform Economies Very Similar
- Initial per capita GDP
- China 175 in 1979
- India 215 in 1991
- Dominant role for SOEs in both countries, with a
particular focus on heavy industry - Allocation decisions subject to direct government
controls - Minimal international trade or FDI
- Tax system had little allocative role
4Initial Reforms
- Relax government licensing restrictions and other
direct controls - Relax controls over allocation of credit
- Cut tariff rates and nontariff barriers
- Relax controls over exchange rate and FDI
- Outcome after 14 years of reform
- China GDP pc grew from 175 to 536
- India GDP pc grew from 215 to 548
5National taxes at beginning of reforms
CHINA INDIA
Corporate Tax 55 rate 50 to 55 rate
Excise Taxes High and variable rates High and variable rates
6High Tax Rates on a Narrow Base
- Revenue only from SOEs in China
- Mainly from large industrial firms in India
- Excise taxes confined to manufacturing
- Yet manufacturing only 16 of GDP (1991)
- 67 of corporate tax from manufacturing
- 40 of revenue from SOEs
7Policies Used to ProtectNarrow Tax Base
- Protect heavy industry with tariffs. In India,
average effective rate was 75 in 1990 (though
reforms cut it to 15 at present) - Provide cheap credit to highly-taxed firms
- Restrict hiring and firing of workers in SOEs
- Direct controls on entry and investment in other
sectors license, permit, quota Raj - Highly taxed industries plausibly larger, rather
than smaller on net, due to tax distortions
8Reforms Relax Controls
- When relax controls, resources (and accounting
profits) shift to low-taxed sectors - Major drop in the role of SOEs, from 68 of
paid-in capital in 1992 to 28 in 2002 - Drop in size of heavy industry, e.g. capital good
production falls from 25 to 7 of GDP - Expansion in size of (lightly taxed) service
sector - Given large tax distortions, reallocation not
necessarily an efficiency gain
9Resulting Fall in Tax Revenue
- In China,
- corporate tax revenue fell from 7.8 of GDP in
1985 to 1.5 in 1993 - Total nontariff revenue fell from 20.5 to 11.5
- In India,
- excise tax revenue fell from roughly 8.4 of GDP
in 1991 to 7.7 by 2004 - But corporate revenue increased from 0.9 to 2.3
- nontariff revenue up from 12.0 to 13.4 of GDP
- Likely reason for difference is improved tax
enforcement in India
10Further Economic Reform Requires Tax Reform
- With relaxed controls, narrow tax base creates
major distortions - Either limit relaxation of controls to preserve
some tax revenue and to limit misallocations, or
undertake major tax reform - China did try a retrenchment in 1988-91, but
political and economic costs too high
11Both Countries Undertook a Major Tax Reform
- After 15 years of reform, both countries largely
replaced excise taxes with a VAT - 17 rate in China
- 16 rate in India
- Both countries broadened the tax base for
indirect taxes - China imposed national taxes on non-SOEs
- India expanding excise tax base to include
services and wholesale sector
12- Both countries cut the corporate tax rate to 33
- Growing importance of personal income tax in both
countries, capturing some income from informal
sector - But while easy to cut rate on heavy industry,
hard to increase effective tax rate elsewhere - Revenue in China fell further, from 12.3 in 1993
to 10.1 in 1996 - With improvements in enforcement, though, revenue
later grew to 17.7 in 2004
13Tax Structure Now More Compatible with a Market
Economy
- Firms now face closer to neutral tax incentives
in allocation decisions - With revenue largely unaffected by allocation,
government finally has a fiscal incentive to
fully support pro-market policies - In China, reforms followed by rapid and
consistent economic growth - In India, a concern that national revenue still
comes largely from manufacturing, plus some from
service sector
14Taxation by State and Local Governments
- If only firms mobile, incentives neutral if
collect same taxes per resident, regardless of
which firms enter - Effective tax rates varied dramatically by type
of firm - In China, tax on profits and sales of local firms
- In India, excise taxes at variable rates on local
firms - Agriculture and service sector very lightly taxed
15Tax Competition
- Incentive to protect heavily taxed firms from
competition from other locations - In China, local governments encouraged entry in
heavily taxed industries by providing valuable
inputs and cheap credit - In India, tax competition undermines revenue
collection
16Implications of Low Tax Revenue
- Poor quality of public utilities immediately
threatens further growth - Poor quality education and health care undermines
longer run growth - Average education is only two years
- Only 35 of age group enrolled in secondary
school - One third of children have low birth weight
17What to Do?
- Hope tax revenue improves
- Chinas revenue has indeed improved gradually,
growing from a low of 10.1 of GDP to 17.7 now - But the economic costs of waiting can be very
high - Borrow against future tax revenue. But current
deficits already 10.3 of GDP - Increased use of user fees, perhaps with private
provision? - Key response in China, particularly for roads,
education, health, telecom - Problem that poor may do without. Use available
budget to subsidize purchase by the poor?
18Is problem low revenue or poor incentives to
provide services?
- Funding for state governments not THAT low
- State revenue plus transfers in India in 2002 was
9.7 of GDP - SL current expenditures in U.S. were 12.9 of
GDP - But current figure for China is 13 of GDP, yet
problems remain severe there - Incentives to provide services seem poor
- Voice Key difference from China. But provides
weak oversight - Exit But mobility across States low due to
language and cultural differences
19How can Incentives be Improved?
- Note that incentives high if have user fees
- Shift funding (and expenditure responsibility) to
panchayats, where mobility pressures are greater - Tie intergovernmental transfers to population
(or of school kids), providing an incentive to
compete to attract residents - Break down barriers to mobility
- Ease restrictions on rental markets
- Ease taxes and restrictions on land sales
20Why is Deficit so High in India?
- Some debt appropriate if tax revenue will
increase in future - National deficit Response to rapid turnover of
party in power? China vs. India or U.S. - State and local deficits Soft budget
constraint? - Parallel problems in China
- No cases of fiscal bankruptcies
- Intergovernmental grants cover any shortfalls,
creating incentives to have high debt or poor
infrastructure
21What is to be Done?
- Shift to fiscal transfers based more on formulas,
e.g. population - Restrict use of debt by SL governments to
capital projects, perhaps with repayment limited
to resulting revenues, a third reason to have
user fees - Set up clearer legal rules to handle defaults on
debts of state and local governments
22Broader Story about Reform Process
- Pre-reform, controls essential to protect narrow
tax base - Reforms relax controls, improving incentives for
firms, but undermining tax revenue - Pressures force move towards a more neutral tax
structure - Incentives on firms and government improve, but
revenue likely falls further in short-term - Can reform policies survive the resulting fiscal
pressures? - Risk that poor infrastructure undermines growth
- Risk of default on debt
- Risk of a populist government undoing reforms